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Created: 23 April 2018

Apr23

2018

Accrued Expenses & Accounting Treatment of Accrued Expenses

In last blog we discussed about Accrual Basis of Accounting v/s cash basis of accounting system. We also understood concept of accrued Income and treatment of accrued income in balance sheet and P&L accounts. In this article we are going to discuss about Accrued Expenses. The concept of accrued expense is also a part of accrual basis of accounting system.

What is Accrued Expense ?

Accrued Expenses can also be called due but unpaid expense. In a business there are certain expenses which may have become due. However, no payment is made towards such expenses as yet. As per accrual basis of accounting, expenses incurred in an accounting cycle must be recorded in the same accounting period. Hence, even though such expenses are not paid, they must be recognised as payable and booked in the books of accounts. Unlike cash basis of accounting where expenses are recorded in the books of accounts only when actual payment is made towards such expenses; in accrual basis of accounting system, expenses must be booked as soon as they become due.

Example of Accrued Expense:

For example, salary for the month of March is due on 31st March 2018. However, salary for March would normally be paid in April. Notwithstanding the fact that salary is not paid, it must be recognised in the books of accounts in the same accounting cycle to which it relates.

Journal Entry to book Outstanding Expenses:

Following journal entry must be passed to recognise outstanding expense when due:

1. Journal Entry for Outstanding Expenses:

Date

Particulars

L.F.

Debit

Credit

31st March

Expense A/c Dr

****

To Expense Payable / Unpaid Expense / Outstanding Exp. A/c

****

2. Journal Entry for Payment of Outstanding Expense:

Date

Particulars

L.F.

Debit

Credit

Date of Payment

Expense Payable / Unpaid Expense / Outstanding Exp. A/c Dr.

****

To Cash/ Bank A/c

****

Explanation:

In the above journal entries Expense A/c, which is an expense ledger, is debited on the date it becomes due. As the expense is related to the current accounting period, it must be recognised in the same accounting period as per matching principle. However, no amount is actually paid in cash as yet. Hence, we need to create an offsetting ledger called "Expense Payable". This ledger is current liability ledger. As long as salary remains unpaid "Salary Payable" ledger would appear on the Liability side of balance sheet.

When unpaid expenses of previous accounting cycle are paid in the next accounting cycle (refer journal entry no. 2 above), it would simultaneously reduce liability side as well as asset side of balance sheet. Hence, no effect shall be observed on the P&L A/c of the current accounting cycle.

Effect on P&L and Balance Sheet when Outstanding Expenses are recognised:

Income Statement of ABC Ltd. for the year ended March 31, 2018

Expences/Losses

Amount (Rs.)

Revenues/Gains

Amount (Rs.)

Outstanding Expenses

******

Note:Outstanding Expenses for a given period would reduce reported profit for the given accounting cycle.